Latest Mutual Fund Figures Distort True Performance

by Dan Wiener | December 2, 2011 1:01 pm

[1]Investors are about to be bombarded with some of the most misleading performance numbers of the year. The reason: Many mutual fund ranking systems, services, and tables and charts use three-year return figures in their calculations and displays. The three-year numbers through November 2011 completely distort true fund performance.

But don’t look for mutual fund companies or ratings services to be forthcoming about these shortcomings.

The numbers are staggering. For instance, the Vanguard 500 Index Investor (MUTF:VFINX[2]) is sporting a three-year annualized return of 14% through November. That’s huge! Imagine compounding your money at 14% for three years — it adds up to a nice 48.3% total return. And that’s not even the best of the bunch.

Looking at Vanguard’s equity funds (a full table is below), you’ll see that the Vanguard Capital Value Inv (MUTF:VCVLX[3]) generated a 26.5% annualized return over the past three years, which, when compounded, is better than a double — generating a total return of 102.6%.

The list goes on and on. In the table below, I’ve compared the three-year and five-year returns side-by-side, and the numbers for most funds look a whole lot different — huge three-year returns and minuscule five-year returns.

But there’s a better way to measure fund performance. It’s called rolling returns.

Check out the two extra columns in the table below. These show average annualized three-year and five-year returns based on every three-year and five-year period over the past decade, rolled ahead month by month. Rolling returns give a much more accurate picture of a fund’s performance. Rather than “point-in-time” numbers, the rolling numbers account for the fact that investors don’t invest all their money at the beginning of the current three-year or five-year period; they invest their money as they can, so they are in fact investing over many three-year and five-year periods.

You may note that for many funds, the average rolling returns are very consistent across three- and five-year periods, unlike the point-in-time numbers most investors are familiar with. This is even true for foreign funds, which, while positive over the last three years, have generated losses over the last five. Those funds’ rolling returns give a more clearheaded view of performance over multiple three- and five-year periods over the past decade.

For an investor, finding a fund that has outperformed over multiple three- and five-year periods is bound to be immensely more satisfying and profitable than finding one that happens to have outperformed over just one. A fund like the Vanguard Dividend Growth Inv (MUTF:VDIGX[4]) may look less appealing because its 3-year return didn’t beat the market. But over many three-year periods, it has nicely outperformed. (The fund is one of my favorites.)

Or consider the Vanguard Windsor II Investor (MUTF:VWNFX[5]), which didn’t beat the market over either the three-year or the five-year period ending in November, but has handily outperformed over many three-year and five-year periods.

I hope you’ll find this of interest, and will view the upcoming onslaught of tables and charts touting three-year returns with a little skepticism.

Happy Holidays.

Annualized

Average Rolling

3-Yr.
Return

5-Yr.
Return

3-Yr.
Return

5-Yr.
Return

DOMESTIC EQUITY

500 Index

14.0%

-1.3%

3.3%

3.6%

Capital Opportunity

17.7%

2.9%

8.3%

8.3%

Capital Value

26.5%

-8.7%

4.8%

4.0%

Convertible Securities

18.2%

21.0%

7.4%

7.5%

Dividend Growth

13.7%

19.0%

5.7%

6.1%

Energy

15.7%

23.3%

17.4%

17.3%

Equity Income

13.3%

7.3%

4.6%

5.0%

Explorer

21.4%

7.3%

5.5%

5.0%

Extended Market Index

21.1%

7.8%

7.3%

6.9%

Growth & Income

13.3%

-7.9%

2.5%

2.7%

Growth Equity

16.7%

1.3%

2.5%

2.9%

Growth Index

18.2%

13.4%

3.4%

3.8%

Health Care

15.1%

20.7%

6.9%

6.8%

Market Neutral

-1.1%

-0.1%

1.6%

2.4%

MidCap Growth

21.3%

20.8%

6.7%

6.8%

MidCap Index

21.9%

6.3%

7.1%

6.7%

Morgan Growth

17.7%

4.9%

4.5%

4.7%

Precious Metals & Mining

36.4%

30.6%

19.2%

19.7%

PRIMECAP

15.5%

11.9%

7.1%

7.2%

REIT Index

26.5%

-11.0%

8.3%

7.5%

Selected Value

20.4%

6.0%

7.4%

6.9%

SmallCap Growth Index

24.7%

20.1%

7.5%

7.2%

SmallCap Index

21.2%

9.1%

7.2%

6.7%

SmallCap Value Index

17.6%

-2.0%

6.4%

5.7%

Social Index

16.5%

-12.7%

1.2%

1.2%

Strategic Equity

19.9%

-6.8%

5.3%

4.6%

Tax-Managed SmallCap

18.8%

9.9%

7.0%

6.4%

Tax-Mgd. Capital Apprec.

15.4%

0.9%

4.1%

4.3%

Tax-Mgd. Growth & Income

14.1%

-1.1%

3.4%

3.6%

Total Stock Market Index

15.4%

1.4%

4.3%

4.4%

U.S. Growth

14.9%

3.6%

2.3%

2.4%

U.S. Value

10.8%

-12.2%

2.6%

2.6%

Value Index

11.1%

-11.5%

4.2%

4.3%

Windsor

15.1%

-14.2%

3.3%

3.2%

Windsor II

13.4%

-5.5%

4.6%

4.6%

FOREIGN FUNDS

Developed Markets Index

10.5%

-16.9%

7.5%

7.9%

Emerging Markets Index

23.9%

20.0%

17.7%

18.1%

European Index

10.3%

-19.2%

7.7%

8.3%

Global Equity

14.6%

-13.4%

7.4%

7.5%

International Explorer

17.8%

-12.7%

11.9%

11.4%

International Growth

16.3%

-4.1%

8.6%

9.1%

International Value

10.5%

-14.8%

9.0%

9.4%

Pacific Index

10.8%

-11.8%

7.2%

7.1%

Tax-Managed International

10.5%

-16.4%

7.7%

8.1%

Total International Index

13.0%

-11.2%

9.0%

9.4%

Notes: Annualized returns are through November 2011. Average rolling returns are based on every 3- or 5-year period, rolling monthly over the last decade.